Following our guide on avoiding inheritance tax, we look at the trusts that can be set up and how they can benefit you and your family.

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Keeping your estate out of the clutches of HM Revenue & Customs (HMRC) when you die isn't easy, but setting up a trust could mean your money goes to your loved ones, not the taxman.

What is a trust?

A trust is a legal contract through which ‘trustees’ are given legal responsibility for holding on to certain assets such as land, money, buildings or share portfolios. Other items such as antiques, paintings, furniture and jewellery can also be placed in trust, sometimes known as ‘chattels’.

The ‘settlor’ – the person who has set up the trust and owns the assets within it – can tell the trustees what to do with the assets and also has control over who should benefit from the trust, known as the ‘beneficiaries’.

More about trustees

Trustees have the task not only of undertaking the wishes of the settlor but also of managing the trust on a day-to-day basis, paying tax that is due, and deciding how the assets should be invested.

There are usually two trustees: a professional such as a lawyer and a family member.

More about beneficiaries

Beneficiaries receive some benefit from the trust. They might benefit from the income from investments or property lets or they may benefit from the capital, such as a portfolio of shares they receive at a certain age. They could also benefit from the income and capital in the trust.

More about settlors

Settlors are people who set up the trust and put assets into the trust – known as ‘settling’ property. Although assets are usually added to the trust when it is set up, you can also add assets at a later date.

Settlors have control over what happens to the assets in the trust and they direct the trustees. They can, through some trusts, also be a beneficiary of the trust.

Why would I need one?

Trusts are set up for a variety of reasons, but usually to safeguard family money either from tax, or from other family members!

You say "The ‘settlor’ – the person who has set up the trust and owns the assets within it" - I beg to differ, and am sure HMRC do also. Once you give anything to a Trust it is no longer yours. It is owned by the Trustees on behalf of the beneficiaries. If you treat it as yours its a sham trust and HMRC will be after you. I think the subject of Trusts is far too complex to put on one page.

This article is useful but some parts are incorrect and misleading. The settlor owns the trust assets at the time of the creation of the trust but ownership then passes to the trustees. The settlor should not direct the trustees as this will result in the trust being a sham with the trustees being no more than the agents of the settlor.

A bare trust arises when a trust comes to an end on the death of the life tenant and the remainder beneficiaries become absolutely entitled. The trustee then has a duty to safeguard the trust assets pending their transfer to the beneficiares. It would be very unusual to create a bare trust as the beneficiary could immediately take control of the trust assets.

As an aside I am a solicitor working exclusively with trusts and estates.

This is a well-meaning article written by someone who unfortunately does not understand trusts, as alluded to in previous comments. Trusts can be set up for a number of reasons, e.g. charitable purposes, but most commonly are set up to reduce tax. I used to work in the fiduciary industry so will give a couple of examples, though they do stray from the subject of inheritance tax.

In a trust, as recognised in the UK, the first party (the settlor) gives away assets to a second party (the trustees) for the benefit of a third party (the beneficiaries). The third party can include the settlor, e.g. Mr Smith might set up the Smith Family Discretionary Trust for the benefit of his wife, children and himself. But the important point to note is that full ownership and control of the trust assets has been relinquished to the trustees. Mr Smith can send the trustees a 'Letter of Wishes' e.g. to say his eldest daughter has started at university so please could the trust pay her £1,000 per month until her studies are completed, and if the trustees consider this appropriate, bearing in mind their responsibility to all beneficiaries, then they would set up payment. Unless the request seems unreasonable then the trustees will act upon it. However, such settlor wishes are not binding and should be infrequent updates of wishes rather than monthly shoppiing lists.

Quite often trusts are set up to hold UK property, and here the settlor may fail to appreciate that he has given up ownership of the property. A common example is for say Mr Bloggs to place UK rental property he owns offshore. Typically the property is placed into an offshore company, e.g. Acme Rentals Ltd, which has two shares both owned by the overlying Bloggs Trust, so that the trust does not own property but shares instead. Trouble is that Mr Bloggs might fail to appreciate he no longer owns the property, so he sets about replacing the bathroom suit or modernising the kitchen, finds a tenant, and sends the bills and letting agreement to the trustees after the event. Mr Bloggs is then acting as a de facto director of the company and so control of the company is thus in the UK, the trust arrangement is a sham, full UK tax applies, and the trustees are placed in an awkward and embarrasing position.

But, as noted above, trusts are complex and good quality tax and legal advice should be sort on the merits of each individual case. The UK has long been tightening the tax rules on trusts so the advantages are not what they used to be.

To answer your question, to avoid UK tax full control of the company and trust must be offshore. If Mr Bloggs is in the UK and acts as a director then UK tax would apply, and the benefits of the company being registered offshore would be lost.

I haven't worked in the industry for some years but the situation in the mid-noughties was that, having set up an offshore trust and company structure to own the property, Mr Bloggs could ask to be appointed as property agent to manage the property. However, in such a case then there would need to be a contract in place appointing Mr Bloggs and all significant decision making powers would have to remain offshore, just as a manager in a normal company would refer substantial decisions to a director. Mr Bloggs would have to abide by his contract. If Mr Bloggs wants to replace the bathroom suite then he should get approval beforehand from the offshore director with submission of an estimate of cost. In the case of a company administered by an offshore trust company, then the offshore director will be an employee or employees of the trust company.

In practice there are two problems. Professional trustees are expensive and typically charge by the hour, plus referring decisions to them takes time to get an reply. And for Mr Bloggs there will always be the temptation to act as if he is the owner and make decisions bypassing the the company in order to get things done. So there will always be the temptation for Mr Bloggs to act as a de facto director, and HMRC are on the lookout for such behaviour.

As mentioned, it's half a dozen years since I was in the trust industry so this advice may be out of date.

Offshore trusts are only effective for UK residents who are non-domiciles and even then they must pay an annual charge of £50,000 for the privlege of having an offshore trust. As such they are only for very rich non-doms.

A person who is UK resident and domiciled can create a life time trust up to the threshold for inheritance tax which is currently £325,000. If he survives for seven years from the date of creation the funds held in the trust fall out of his estate and are free of tax when he dies.